In commercial property the two most common types of leases are Net Leases and Gross Leases. Understanding both types is important when calculating the return on your investment.
The Lessee (Tenant) pays a fixed pre-agreed amount which is typically higher to allow for outgoing expenses. The pre-agreed amount is designed to include an allowance for land tax, council rates, water rates, insurance, management fees, strata levies etc. A gross lease therefore does not allow for any recovery of outgoing expenses over and above the agreed rent payable. Basically it’s a rent amount designed to be inclusive of all bills. You cannot, therefore, charge your tenant more if the bills become higher.
Gross leases involve less administration. There is only one incoming payment and no requirement for budgets or reconciliations.
There can be an income vs outgoing cost disparity. For example, if your lease is subject to an annual CPI (Consumer Price Index) rental increase & your property’s expenses then increase above inflation – you (the landlord) are liable for the difference.
The Lessee (Tenant) pays a base rent amount & are also then responsible for the payment of outgoing expenses. Typically, the tenant pays a percentage of the total outgoing expenses that is directly proportionate to the amount of lettable space they occupy.
It is much easier to determine your net income position. The rent received is separate to the outgoings recovered – therefore if expenses increase, the additional cost is then absorbed by the tenant.
Detailed budget and reconciliation needs to be carried out which involves more time and administration. Often regular audits are also needed to determine any shortfall or overpayment by the tenant.
So, which is better?
It’s not entirely black and white. Net Leases are generally a safer bet for landlords. It means you’re less likely to be out-of-pocket during tenancies.
However, it’s always best to consult an experienced commercial property manager to make sure there are aren’t other factors at play. Both types exist because every property and every portfolio is different, what works for one, won’t necessarily work for another. A Commercial Property Manager can help you understand the different facets of these commercial lease agreements and help structure them in a way that is produces the best income on your investment.
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